Opportunity Zone Regulation Takeaways
Important Take Highlights from Recently Released Regulations
On Wednesday, April 17th, the second round of proposed regulations for the Opportunity Zone program was released. This release was long awaited by Opportunity Zone market participants. The team overseeing this process at the United States Treasury went through great lengths to help answer some of the biggest outstanding questions—how debt financed distributions will be treated, will investors be taxed on depreciation recapture, will recycling of capital gains be allowed—but still punted on others. In other words, while the second round of regulations answered a lot of the large outstanding questions, we should still expect another round to be released to answer some of the remaining questions.
The team here at RevOZ has laid out, in easy to understand terms, the top takeaways from the recently released regulations. Please reach out to your team here at RevOZ for any questions!
Debt Financed Proceeds: Financed debt proceeds distributed to investors are tax free up to their basis in their ownership interests in the QOF.
Ability to Purchase Property Prior to C of O: A property qualifies as “originally used” in an OZ, and thus qualifies for OZ purposes, if it is purchased prior to being “placed in service”. A property’s placed in service date is generally signified by the date its owner obtains a C of O.
Reinvestment of Proceeds/Recycling of Capital Gain: An QOF will not lose its status as an QOF if it reinvests proceeds from the sale of an underlying property into another qualifying deal within 12 months. However, the ultimate investors will still be required to recognize gains from the sale of such property (unless they have held their interest for 10 or more years).
Land: Land does not need to be “substantially improved” to qualify for OZ purposes, however, it must be used in an active trade or business to qualify.
Vacant Property: Property that has been vacant for 5 or more years will qualify for OZ purposes without being “substantially improved”.
Leased Property: Essentially, leased tangible property qualifies for OZ purposes so long as it is obtained at market rate. Further tests applied if it acquired from a related party, however, it does not need to be “substantially improved”.
Multi-Asset Funds/Election to Exclude Capital Gains: Taxpayers who hold their QOF interests for 10 or more years may make an election to exclude from gross income some or all of the capital gain from the disposition of OZ property reported on the Schedule K-1 of such QOF. Note, the Treasury Department and the IRS intend to implement targeted anti-abuse provisions with respect to this election.
Treatment of Carried/Profits Interests. OZ benefits are not provided for capital gains from carried/profits interests. There is little guidance provided on the bifurcation calculation of capital gains from an capital interest and that of an carried/profits interest.
Qualifying Real Estate Businesses and Triple Net Leases. The ownership and operation (including leasing) of real property is the active conduct of a trade or business. However, merely entering into a triple net lease of property is not the active conduct of a trade or business for QOZB purposes.
QOZB 50% Active Trade or Business Test. The proposed regulations provide three safe harbors and a facts-and-circumstances test for determining whether sufficient income is derived from a trade or business in a QOZ for purposes of the 50% test. The safe harbors look to the amount of services, payment for employees, and management functions performed within the OZ.
Purchase of Other’s QOF Interests. Taxpayers can acquire an eligible interest in a QOF by purchasing it from an existing partner of the QOF.
Multiple Working Capital Safe Harbor Elections. A QOZB can make multiple, overlapping working capital safe harbor elections so long as each election satisfies the requirements.